The markets are slumping as investors worry about the consequences of the Federal Reserve’s aggressive interest-rate hikes, designed to fight an inflation rate that’s the highest in 40 years.
The feverishness of investors was marked by the Sept. 13 equity-market rout that followed a report confirming that inflation is not easing.
This hotter-than-expected inflation report wiped almost $1.6 trillion from the S&P 500, marking the worst session for U.S. stocks since June 2020.
The rout particularly affected risky assets such as technology groups. The Nasdaq 100 lost more than 5.5%.
The inflation report bolstered investors’ expectation that the Fed would raise rates by at least 0.75 percentage point, or 75 basis points during its two-day meeting on September 21-22.
Core U.S. consumer prices jumped 0.6% last month, powered not only by rising rents but also by accelerating pressures across a broad range of the products and services. The figures suggested that pressures have yet to peak in the world’s biggest economy, data from the Bureau of Labor Statistics indicated.
0.25, 0.75 or 1 Percentage Point
The headline consumer price index for the month of August was estimated to have risen 8.3% from a year earlier, down from the 8.5% pace recorded in July but faster than the Wall Street consensus forecast of 8.1%.
The report, however, also increased bets that the Fed would raise a full percentage point, or 100 basis points.
“Today’s CPI report confirms that the US has a serious inflation problem,” commented former Treasury Secretary Larry Summers on Twitter, He’s one observer who says the Fed must go even faster in its monetary tightening.
“It has seemed self evident to me for some time now that a 75 basis points move in September is appropriate. And, if I had to choose between 100 basis points in September and 50 basis points, I would choose a 100 basis points move to reinforce credibility,” Summers, who is president emeritus of Harvard University, added.
A hike of 0.75 point or, worse, a full point will choke the economy and cause the nightmare scenario of deflation, says Elon Musk, chief executive of electric vehicle leader Tesla (TSLA) . The billionaire thus suggests an increase of 0.25 percentage point.
“Drop 0.25%,” Musk tweeted on Sept.14.
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The tycoon, who is also involved with three other companies — SpaceX, Neuralink and Boring Co. — made the suggestion after a Twitter user asked him what the Fed should do as it balances between fighting inflation and avoiding catastrophe for the economy.
Early Signs of Deflation?
It all started with a tweet from Ark Investment Management’s Cathie Wood warning of early signs of deflation. The prices of many raw materials have recently fallen sharply, the star financier noted.
“Deflation in the pipeline, ” Wood warned. “Heading for the PPI, CPI, PCE Deflator: from post-COVID price peaks, lumber -60%, copper -35%, oil -35%, iron ore -60%, DRAM -46%, corn -17%, Baltic freight rates -79%, gold -17%, and silver -39%.”
“Exactly, this is neither subtle nor secret,” Musk commented.
“What should the fed do?” asked a Twitter user.
This is the second time in less than a week that Musk has warned against a jumbo interest rate hike by the Fed.
On Sept. 9, the influential CEO, who has nearly 106 million followers on the social network Twitter, had warned that if the central bank raised its rates by 75 basis points, the move would provoke deflation, which means most goods and services would become ridiculously cheap.
“A major Fed rate hike risks deflation,” the billionaire said.
Basically, Tesla’s CEO is saying the Fed is going too far, too fast and must slow down.
Deflation is the opposite of inflation. It is characterized by a continuous fall in the general level of prices. It can encourage households to postpone their purchasing decisions as they wait for further price declines, economists say. The consequences can be devastating as overall consumption slumps. Then, companies that can no longer sell their products reduce production and investment.
Above all, deflation can cause borrowers’ financial situation to deteriorate. That’s because the real, or inflation-adjusted, cost of debt increases because loan repayments generally aren’t indexed to inflation. So companies are less able to invest and households are less able to buy necessities and consume.
Instances of deflation are rare in rich countries. Just two incidences of deflation have occurred in the past century: the 1930s, which affected the U.S. and then Europe, and the Japanese economy at the end of the 1990s.